498. Is the exchange of one annuity contract for another permissible if the owner-beneficiary inherited the annuity from a deceased original owner?Stevenrcline202012-09-06T16:34:00Z2015-04-28T20:17:00Z2015-04-28T20:17:00Z24472551Summit Business Media215299314Site Map/Annuities/Nonqualified/Disposition/Policy Exchanges1035 exchange Q30 302005-01-24T00:00:00ZTaxFactsDefaultArticleEthics and 1035 Exchanges.pdfSite Map/Annuities/Quick Clicks/1035 ExchangeEthics and 1035 Exchanges.pdf10030-00-TF1.xml30.00;#1589;#1592;#0x010100C568DB52D9D0A14D9B2FDCC96666E9F2007948130EC3DB064584E219954237AF3900242457EFB8B24247815D688C526CD44D009C4E67E972694125ABDA91AC61F5E51FTax Facts 1Does tax liability arise when a policyholder exchanges one annuity contract for another?
1285123600.000000000TaxFactsDefaultArticleSBMEDIA\cjump2010-06-04T10:54:51Z498. Is the exchange of one annuity contract for another permissible if the owner-beneficiary inherited the annuity from a deceased original owner?In general, the original owner of a nonqualified annuity product is able to exchange one annuity for another in an IRC Section 1035 exchange without treating the transaction as a sale—no gain is recognized when the first annuity contract is disposed of, and there is no intervening tax liability. Despite this, Section 1035 requires that, for the annuity exchange to be tax-free, the newly acquired annuity must be payable to the same individual that was entitled to annuity payouts under the original annuity. .IRC Sec. 1035. The IRS has ruled privately that the beneficiary who inherits rights to payouts under an annuity also inherits an ownership interest in the annuity that is sufficient to allow tax-free exchange treatment under IRC Section 1035. .Let. Rul. 201330016. In the IRS ruling, the beneficiary inherited multiple annuity products and elected to receive distributions over her life expectancy after the original account owner’s death. Later, she found an annuity product that offered more attractive investment features and sought to exchange the original contracts for an annuity that would increase her annuity payout, but would continue to distribute those payouts over her life expectancy. By allowing this exchange, the IRS permitted the beneficiary to exchange the entire pre-tax value of the inherited annuity, rather than requiring that she take a lump sum distribution of the inherited annuity interest, pay taxes on this distribution and then purchase the replacement annuity contract with the after-tax value.However, the IRS was careful to note that the rules applicable to post-death distributions still apply, meaning that the newly acquired annuity must require distribution of the entire interest in the inherited annuity within five years or over the beneficiary’s life expectancy.Planning Point: Unfortunately, given that the Private Letter Ruling allowing post-death 1035 exchanges was just that – a Private Letter Ruling – insurance companies are not bound and required to honor it. In practice, as with many PLRs pertaining to annuity companies, some have acquiesced, while others have not. As a result, for situations where a beneficiary is interested in completing an inherited annuity post-death 1035 exchange, it may be necessary to seek out companies that are specifically willing to cooperate with the assignment of contract necessary to facilitate the exchange. In addition, the original annuity must be liquid enough at death – i.e., not have certain required payout provisions – to allow it to be liquidated and transferred pursuant to a (post-death) 1035 exchange in the first place. Michael E. Kitces, MSFS, MTAX, CFP, CLU, ChFC.